The Return of Fossil Fuels

Enormous new oil and gas discoveries under American soil are having a game-changing impact on the entire economy. How to play the new energy boom.

By

ReshmaKapadia

AlyssaAbkowitz

IanSalisbury

MissySullivan

For pharmaceutical executive Abe Abuchowski and his wife, Mary Nucci, going solar meant a little pain for what they hoped would be years of gain. The couple decided in 2011 to convert their 3,500-square-foot colonial home in Hunterdon County, N.J., to solar power, and they endured a barrage of banging hammers and droning electric drills on their roof as a crew installed the photovoltaic panels. The total price tag: a daunting $120,000. Still, by the couple's calculations, the ruckus and money would be worth it; with energy prices climbing toward the stratosphere, they'd recoup their costs in five years.

Less than a year later, Abuchowski is second-guessing the decision. Since his panels went up, New Jersey's home-energy rates have bucked a decade-long trend and started to dip, and local utilities no longer pay top dollar for the electricity from his home grid. One culprit behind the unexpected reversal, experts say: natural gas, which is driving down power prices all over the Garden State and undercutting the alternative-energy business just about everywhere. Now, Abuchowski says, the money math looks a lot different: "It could take 25 to 30 years to recover what we paid."

It used to rank up there with death and taxes -- the certainty of the rising price and eventual disappearance of fossil fuels. For a generation and beyond, images of oil dependency were drummed into the American psyche -- in the form of long lines at gas stations, secretive overseas oil barons and screaming headlines about $100-a-barrel crude. And our spending and investing alike have reflected our energy anxiety. Americans have bought 1.6 million hybrid cars since 2007, putting up with higher sticker prices in order to cut back on trips to the pump. Almost every community has a few homes that sport shiny solar panels. And most of us have hedged our portfolios to cope with fuel fear: ExxonMobil is one of the most widely owned stocks in America, but in 2008, shares in alternative-energy darling First Solar cost three times as much as the petroleum giant's.

So what's different now? To put it crudely, our economy has been fracked up. Fracking is the extraction technique that has enabled drillers to tap enormous new reserves of natural gas across the country -- a 75-year supply, by some estimates, with the potential to change the economics of everything from the electricity that runs our iPads to the trucks that deliver them to our doors. And natural gas isn't the only historical fossil that's resurfacing; North American oil production is also bouncing back, driven by technological breakthroughs that have brought hard-to-reach sand and shale deposits into the fuel fold. "The shale revolution could transform our economy," says Sarah Emerson, president of research and forecasting firm Energy Security Analysis, who has been covering the industry for 25 years. "The potential here is phenomenal."

Those game-changing ripples are being stirred up, appropriately enough, by water -- specifically, the millions of gallons that engineers pump underground as part of the fracking process. First widely implemented in the 1980s, fracking technology now enables energy companies to tap deposits that they once regarded as too costly to extract. In the past few years, the Marcellus Shale in the Northeast has emerged as what could be the U.S.'s largest natural gas field, while oil drillers have descended on North Dakota and Montana to tap the enormous Bakken Formation, which geologists estimate may hold as much as 10 billion barrels of recoverable oil. The impact on the energy industry has been immediate: In the first four months of this year, the U.S. imported only 42 percent of the oil it consumed, the lowest level in nearly two decades, and the country is producing more natural gas than ever. In fact, says Michael Avery, a portfolio manager at the $27 billion Ivy Asset Strategy fund, "the U.S. is the only energy-producing country with significant, sustainable production growth."

As revolutionary as these new fuel sources may be, their impact won't hit home immediately for most people. Most notably, rising oil production is a long way from making a big dent in prices at the gas pump. Still, the new energy boom is already creating upheaval in a host of other sectors, producing some unexpected new winners and losers. Cheap natural gas, for example, has been a bonanza for companies that burn a boatload of it, like utilities and chemical giants. And nowhere has the impact of cheaper fuel been more stark than in the alternative-energy industry, which has had the green rug pulled out from under it. Solar-, wind- and even some nuclear-power providers all saw their share prices soar when $8-a-gallon gas seemed inevitable; now they're struggling to compete.

Amid this turmoil, the savviest investors are quietly shifting gears, trying to anticipate which companies could benefit from more domestic gas and oil, and which could be hurt the most. Those calls aren't as slam-dunk obvious as they may appear from a distance, of course, and even for Main Street types who wouldn't know a refinery from a Ferris wheel, the implications are big. Is it too soon, or too late, to add more energy stocks to a retirement portfolio? Is it still worth paying a premium for a car that sips at the gas pump -- or skips it altogether? The only certainty, economists and analysts say, is that these decisions will remain tricky as the energy dice continue to roll.

Oil

Equipment makers and oil drillers are profiting from big new oil finds. The next challenge: converting those discoveries into cheaper fuel.

It may sound contradictory, but investors say it's true: You can thank high oil prices for breakthroughs that might someday make prices lower. When prices are high, energy companies have the incentive (and cash) to figure out how to tap hard-to-reach reserves. The past decade proves the point. Fueled by demand from the developing world, oil prices have risen 265 percent in 10 years. The industry, in turn, put more resources into fracking and horizontal drilling -- techniques that opened up huge North American finds like the Bakken and the oil sands of Alberta. Before the oil-price boom, says Brian Hicks, comanager of the $500 million U.S. Global Investors Global Resources fund, these reserves would have been unprofitable; now they're anchoring "a gold rush."

Some companies have already seen a big payoff from the new finds. Oil producer Continental Resources has the biggest stake in the Bakken field, leasing nearly a million acres. Jeff Hume, Continental's vice chairman of strategic growth initiatives, says the company is on track to triple its production from 2009 levels by the end of 2013. And he says a slew of other businesses are benefiting from its shale plays -- from makers of memory chips used in pumping equipment to the restaurant and hotel operators flocking to serve oil-field workers. Indeed, some investors see bigger opportunities in those smaller hangers-on. Donald Coxe, whose Chicago-based investing firm specializes in commodities, favors companies that make specialized equipment for extracting oil from the Alberta sand fields. Such processes present technical challenges and, as environmentalists note, major pollution problems. But Coxe says the payoff is 50 to 75 years' worth of oil reserves: "Your grandchildren can get dividends."

Of course, many consumers are painfully aware that they haven't seen dividends yet, at least not in the form of lower gasoline prices. That's partly a result of high global demand -- the fuel burned by a Buick owner in Beijing drives up prices for a minivan-driving mom in Memphis. But analysts say the U.S. also has a distribution problem, in the form of a pipeline shortage, which could mean an opportunity for master limited partnerships, or MLPs, that specialize in operating such pipelines. MLPs have soared in popularity and price, as investors have flocked to their high yields. But Hicks thinks these MLPs will continue their strong run, and his fund is committing about 8 percent of its assets to MLPs, up from zilch five years ago.

Handicapping energy stocks could be a first step on the road to something bigger. If U.S. oil production does eventually help cut oil prices, it could boost any company for which fuel is a major expense -- think major shipping firms, or the nation's airlines, which burn 47 million gallons of jet fuel a day. The price of oil will still be determined by global forces, says Emerson, the energy analyst, but the U.S. "will influence it in ways it hasn't in decades."

Natural Gas

With gas cheap, manufacturers and power companies are shifting the way they work. But who will keep winning when prices rise?

Back in the late 1970s, energy consultant and regulator Branko Terzic appeared before Congress to deliver some bad news. The U.S. was facing a natural gas shortage, he told lawmakers -- one so bad that he was advising clients and regulators to write off their natural gas plants as worthless. The U.S. was shutting off gaslights on little old ladies' porches and even dousing the flame in the John F. Kennedy Memorial to make sure there was enough gas left to heat homes, Terzic recalls. "It was one absurdity after another."

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